In particular, in the Marks & Spencer case, the ECJ concluded that Member States had the possibility to restrict European fundamental freedoms by means of abuse prevention schemes. There, the ECJ developed the principle that even final losses of a foreign subsidiary do not have to be taken into account by the parent company if the refusal to take account of abuse prevention serves. We explain when such abuse prevention is considered.

1st context of the decision

1.1. Problem: Setting off losses with foreign subsidiaries

In the Marks & Spencer case, the European Court of Justice (ECJ) had to decide in substance to what extent losses from foreign subsidiaries can be taken into account in the parent company of the group with its registered office in England.

Marks & Spencer plc retail chain is headquartered in the United Kingdom. The group includes subsidiaries in Germany, France and Belgium. The subsidiaries achieved a loss of approximately 150 million euros. Marks & Spencer wanted to take these losses into account as part of its tax return in England – i.e. at the group parent company. However, the corresponding application of the parent company rejected the English tax administration. The reason for the refusal was that the group deduction was limited to profits and losses falling within the scope of UK tax law. The claimed losses are those of the subsidiaries and therefore not eligible in England.

1.2.Law in England at that time

In English tax law, there was the possibility of group taxation at that time, whereby the parent company of a group could offset its profits against the losses incurred in its subsidiaries ("group relief"). However, as the British tax administration had correctly recognised, this offsetting of losses was limited to profits and losses which fall within the scope of British tax law. The High Court of Justice submitted these rules to the ECJ in the context of the preliminary ruling procedure and had them examined for their conformity with European law.

1.3. Denial of loss offsetting disproportionately at final loss

In principle, the ECJ recognised as justified the refusal to offset losses and the associated interference with the freedom of establishment. The refusal is justified by the division of taxation rights between the Member States. However, the refusal to offset losses must also be proportionate. It is disproportionate if the loss of the subsidiary is no longer fully taken into account in any state by offsetting losses. Rather, a one-time use of the losses in Germany must be ensured. If the losses of the subsidiary are final in other EU countries, the Member State must allow the parent company to offset losses. However, the loss consideration via this way should only be made possible in exceptional cases – the case that final losses are present is the exception. Whether this exceptional case exists, the taxable person must prove.

1.4 But: Return exemption for abuse prevention

However, the ECJ introduces an exemption. As a result of the derogation, Member States do not have to take into account any finalised losses for the purpose of offsetting losses. This is possible through concrete abuse prevention by the Member States in order to avoid loss transfer practices. If the Member State's objective is not to take a final loss into account for the purpose of combating abuse, this is legitimate.

2nd Abuse Prevention in German Law

For the European requirements for standards of abuse prevention, the German regulation could give an indication. § 42 AO is the central German regulations for abusive circumventions. However, the Bundesfinanzhof (BFH) has already determined at an early stage that in principle every taxpayer is free to set up his affairs in such a way that he pays as little tax as possible. The limit for abuse is exceeded if the taxpayer chooses a legal arrangement that is inappropriate to achieve the objective pursued, is intended to reduce the tax and cannot be justified by economic or other significant extra-tax reasons.

Accordingly, the reference point of the abuse accusation is the inadequacy of a legal arrangement. The inadequacy of a design can be determined on the basis of the evaluations of the potentially circumvented tax law. Accordingly, there is an abuse of design to be sanctioned if the chosen design is intended precisely for tax avoidance according to the evaluations of the legislator, which are the basis of the respective relevant provision. Economic freedom also includes making uneconomic decisions. However, a legal arrangement which proves to be cumbersome, complicated, cumbersome or artificial against this background can have an indicative effect on the inadequacy of the arrangement. Such a design typically obscures what is really intended, in that it is intended to obstruct the view of the economic goal by the complicated design form.

Avoiding abuse in European tax law

3.1. No definition of abuse prevention

The ECJ leaves unclear, however, the question of when losses of the subsidiary are improperly finalized and thus should not be taken into account by the parent company. He does not make a definition. There is also no fixed European concept of abuse. The German financial administration will often try to close the possibility opened by the ECJ for an import of foreign loss by indicating risks of abuse. It is therefore only possible to determine by interpretation what combating abuse actually means.

It is possible to finalise a loss abusively in the sense of the ECJ case-law. The reason for this is in particular that the ECJ hardly comments on the definition of the finality of the loss. It is conceivable for a subsidiary, for example, that it is always liquidated at the time of entering the profit zone and a new company is founded. This then continues the same, but in the future profitable activity under a new company. Then the losses could be exploited in the high-tax country. Furthermore, liquidation can also be worthwhile if the subsidiary does not expect any profits in the future. This makes it possible to offset losses in the state of the parent company, which can justify liquidity advantages.

3.2 Objective and subjective criteria

The ECJ appoints as a prerequisite of the European understanding of abuse an objective and a subjective element. Objectively, the accusation of abuse is based on the respective standard purpose of the regulation, which is to be undermined. In this respect, however, European and national principles differ considerably. German tax laws aim to curb tax avoidance. The ECJ, on the other hand, strives to avoid restrictions on market freedom (as is the case with abuse prevention regulations) as much as possible. On the contrary, the choice of a tax-favourable location serves precisely to create the internal market. On the other hand, abuses by the Member States always restrict the internal market.

Abusive designs should be available according to the “Cadbury Schweppes” decision, if the design is purely artificial and distant from any economic reality. False activities undermine the ideal of integration and integration into the economic structures of the host state, but this should be linked to establishment. A low minimum of economic substance must be fulfilled.

As a subjective requirement, it is necessary that the taxpayer strives for a tax advantage. However, the focus is on examining the objective features of an artificial design.

3.3 Freedom of Member States to design

However, the ECJ recognises to a certain extent that Member States can specify the fight against abuse within the framework of their freedom of design. In particular, presumptions of abuse can be typed and the burden of proof can be shared at the expense of the taxable person.

3.4. Avoidance of abuse in case of loss offsetting

These requirements for the prevention of abuse require specification, especially in the case of cross-border loss offsetting. In particular, in the case of a liquidation or cessation of a permanent establishment, many actual aspects must be weighted. The assessment of these factual circumstances must also be carried out in accordance with certain guidelines. If the legislature wishes to exclude certain forms of finality, it must specifically declare the situation of abuse. However, he must not fail the loss offsetting too much – in a way that is no longer necessary. Therefore, the limitation of loss offsetting must not be too broad. On the other hand, the regulation must still be open to unforeseen circumvention approaches. Consequently, it must not be too broad.

The taxpayer is only able to offset losses in the State of the parent company if he actually makes use of the loss allowance options available in the State of the subsidiary. If he does not make use of the existing loss allowance possibilities, he could already act abusively in this respect.

It would therefore be conceivable that the loss that has become final due to a conversion abroad has been self-responsible. Particularly in the case of cross-border loss offsetting, there is regularly considerable self-interest. The loss can be postponed in a group in such a way that the actual value of the loss becomes highest because it can be used best for tax purposes.

The abuse in the context of loss offsetting is therefore not about letterbox companies or other sham activities in Member States. Rather, it is a question of whether a tax operation is carried out solely in order to achieve a tax-favorable placement of losses. Therefore, the key factor is whether extra-tax factors justify the tax factor. It must therefore be possible for the Member State to verify the existence of these extra-tax factors. If the taxpayer cannot prove extra-tax reasons, abuse is obvious. Therefore, if a subsidiary is liquidated only in order to re-establish it, the sole purpose of this action is to shift losses.

Standardization of Abuse Prevention

Then this abuse threshold must also be covered in the law in a way. This raises the question of whether it is necessary to develop a specific regulation to prevent abuse. This could be required under EU law. However, it could also be sufficient to resort to the general abuse prevention regulation.

In the context of cross-border loss offsetting, it is possible to insert a rebuttable presumption against the finality of the closure of the permanent establishment into the law in the case of the closure of a foreign permanent establishment, which is difficult to regulate. The taxpayer would then have to refute this presumption. In particular, the taxable person could present economic reasons and the durability of the termination of the permanent establishment activity. In practice, however, this should not prevent taxpayers from offsetting losses as final losses. Rather, they will probably regularly provide formal proof of at least extra-tax motivation of the measure.

Especially at the establishment, however, a reliable process for recognizing the finality of losses is required. It would be conceivable for the taxpayer to insure this information in accordance with § 95 AO instead of Eides. The intentional or negligent delivery of a false federal insurance is punishable according to §§ 156, 161 StGB. The insurance is false if the facts whose accuracy is assured are untrue, authoritative information has been omitted or untrue information has been added to the facts. For example, it could be insured that the activity is not resumed.

Otherwise, the regulation of § 42 AO could be specified in individual cases. However, European law principles must be observed. Indeed, it also constitutes discrimination if more stringent obligations of proof apply to foreign property conduct than to purely domestic property conduct. However, the ECJ allows this to a certain extent. In this respect, a duty to cooperate that corresponds to the standard of § 90 paragraph 2 AO is in conformity with European law.